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The General Theory of Employment, Interest, and Money
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Part 5Chapter Summaries & Analyses
Part 5: “Book V: Money-Wages and Prices”
Part 5, Chapter 19 Summary: “Changes in Money-Wages”
Keynes scrutinizes the notion that reducing money-wages automatically boosts employment—a cornerstone of classical economic theory. He argues that this classical view rests on the erroneous assumption that a decrease in wage rates always makes production cheaper, raises profits, and thus incentivizes businesses to employ more labor. In fact, for the community as a whole, a wage reduction does not necessarily lift effective demand. Keynes clarifies that the total volume of employment depends uniquely on the level of aggregate demand (i.e., consumption plus investment), so any alteration in money-wages must be examined through its repercussions on consumption behavior, the marginal efficiency of capital, and the interest rate.
He identifies seven possible routes by which lower money-wages could affect output—such as redistributing purchasing power or impacting liquidity preference—but emphasizes there is no guarantee that net effects will spur overall employment. For instance, lowered wages can reduce workers’ spending power, diminish confidence, and raise the real burden of debt, offsetting any cost advantage to employers.
Further, Keynes contrasts a strategy of wage reductions with the alternative of expanding the money supply. Although each approach theoretically lowers the “real wage” in different ways, increasing the money supply is simpler and avoids the intense social frictions (and potential collapses in confidence) triggered by wage cuts. He also notes that sticky money-wages, especially in modern conditions, often lead to only moderate price changes—insufficient to “naturally” restore full employment. Crucially, Keynes contends that unwavering reliance on wage flexibility betrays the complexity of a monetary economy, where interest rates and future expectations shape investment far more than small changes in labor costs do. Ultimately, he concludes that attempting to maintain full employment through shifting wages alone is both impractical and uncertain. Instead, he advocates stable or gently rising money-wages, combined with deliberate policy to influence interest rates and manage aggregate demand, as more effective levers to sustain employment.
Part 5, Chapter 20 Summary: “The Employment Function”
Keynes formalizes the relationship between the level of employment and the aggregate supply price of output through what he calls the employment function. He reasons that each industry’s output responds to the effective demand directed toward it, with different industries showing different “elasticities of employment” (174): Some can ramp up output and jobs easily when demand rises, while others respond slowly or not at all. By converting the usual supply curves into this new framework, Keynes clarifies that total employment depends not just on aggregate demand in wage-units, but also on how that spending is distributed among various industries. If certain industries have low employment elasticity, an increase in demand goes more to profit or price than to boosting jobs.
He also discusses short-run fluctuations, noting that when overall demand increases unexpectedly, existing surplus capacity can initially raise employment efficiently, but once that surplus is used up, rising costs limit further job growth. Finally, Keynes analyzes why stabilizing prices perfectly is impossible in a dynamic economy: Price shifts inevitably occur, but they do not by themselves spur new capacity if entrepreneurs can’t profitably expand. Ultimately, the chapter underlines that the employment function offers a more holistic way to think about industry-level and aggregate supply responses to changes in demand.
Part 5, Chapter 21 Summary: “The Theory of Prices”
Keynes tackles the challenge of reconciling traditional micro concepts of cost and demand with the macro concept of the price level in a monetary economy. He notes that economists often shift abruptly from talking about marginal cost and supply curves for individual industries to a separate and more ambiguous discourse on money, velocity of circulation, and inflation/deflation. Keynes seeks to unify these perspectives, showing how the wage-unit (or a broader “cost-unit”) is a critical bridge between micro- and macro-level price theory.
He argues that the general price level depends on how rising effective demand is split between increasing employment and lifting the wage-unit, particularly once bottlenecks in production are reached. In a world with underemployed resources, more money or effective demand initially goes mostly to output and jobs. But as the economy nears full capacity, additional spending increasingly boosts wages and prices rather than real activity. Keynes highlights numerous complicating factors, including the distribution of spending across industries, the possibility of diminishing returns, the uneven flexibility of money-wages, and the unpredictable behavior of liquidity-preference. Ultimately, he contends that a fully satisfying theory of prices cannot be divorced from changes in expectations, interest rates, and the realities of monetary policy. Prices are not strictly determined by supply and demand for individual products; instead, they emerge from a complex interplay of macro-level spending, wage rigidities, and how entrepreneurs react to uncertain future prospects.
Part 5 Analysis
Keynes underscores that lowering money-wages does not guarantee more employment, since pay reductions can undermine spending power without necessarily increasing firms’ incentives to hire. Although classical theory assumes that cheaper labor entices producers to ramp up production, Keynes counters that if workers can afford less, businesses may face lackluster demand for their output. “The economic system cannot be made self-adjusting along these lines” (165), he remarks, emphasizing that real-world frictions prevent wages from declining uniformly and painlessly. Instead of viewing rising unemployment as a signal for employees to offer their labor at progressively lower rates, Keynes points to the larger problem of insufficient purchases to justify additional hiring.
This critique reinforces The Power of Aggregate Demand: When overall spending lags, trimming wages merely shifts purchasing power rather than expanding it. Keynes clarifies that “the volume of employment is uniquely correlated with the volume of effective demand” (161), dismantling the classical argument that cost-cutting alone will stimulate job growth. Wage cuts can erode consumer confidence, exacerbate debt burdens, or alter liquidity preferences, rendering labor no more attractive at a reduced price. By rejecting self-correction through wage flexibility, Keynes highlights how real-world behavior intersects with nominal changes: Workers are unlikely to accept steady pay cuts, and even if they do, the resulting drop in consumption might cancel out any short-term competitive advantage for employers.
To move beyond a pure cost-based view, he formalizes an employment function that considers how effectively each industry translates additional spending into new jobs. While a rise in demand can swiftly spark hiring in some sectors, it might inflate prices or profits in sectors that have limited capacity to expand. This dynamic reveals the Psychological Underpinnings of Economic Behavior: Entrepreneurs in capacity-constrained industries might shy away from growth if they doubt that demand will last or find expansion costs too risky. Meanwhile, a booming sector may not create enough new opportunities to lift overall employment. By focusing on varied elasticities of employment, Keynes shows why widespread wage cuts or temporary price spikes will not naturally align supply and demand for labor in a sustained way.
He then addresses broader pricing mechanisms, arguing that windfalls often fail to motivate new capacity if firms remain uncertain about future sales. Rather than suggesting that every shift in demand neatly adjusts supply at steady prices, Keynes believes price and wage behavior reflect a complex interplay of spending, resource availability, and risk perceptions. Though these chapters do not prescribe direct interventions, they implicitly open the door for Government Intervention and the Public Sector’s Role, since individual firms may continue withholding investment even under falling wages. By weaving together demand, industry-specific constraints, and the limitations of cost-driven adjustments, Keynes offers a robust critique of classical assumptions that wage cuts alone will restore full employment. Instead, he indicates that supporting or gradually raising wages can maintain consumption, while broader measures—such as managed credit, public spending, or stable price targets—often yield more reliable corrections than hoping a downward cycle in wages will naturally revive job growth.
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